Saturday, January 31, 2009

Some Silicon Valley companies having second thoughts on outsourcing

Source: SiliconValley.comThe global recession — combined with the Satyam Computer Services scandal and the terror attacks in Mumbai — is changing the once rosy portrayal of endless good days for the growing outsourcing industry.

Silicon Valley companies now must grapple with the risks of sending critical functions offshore even while the economic downturn adds to the pressures to cut costs."We are in an environment where companies want to save money, but they also want to avoid risks. Offshoring is seen as an adventurous and risky thing to do," said Forrester Research Vice President Andrew Bartels.

While outsourcing is now a permanent fixture in many American business plans, the industry is facing its greatest challenge ever.

In India, software services companies face tough negotiations as clients seek to further trim costs. At the same time, they are subjected to greater scrutiny to ensure they are reliable and financially stable. In China, contract manufacturers are shutting factories, raising questions about their reliability as well as China's prospects as millions of migrant workers face unemployment.

The once high-flying outsourcing industry that boasted stunning growth has begun to slow dramatically. Infosys, India's second-largest outsourcing company, last month reported its first sequential quarterly drop in revenue and sliced its guidance for the year for the second time. Wipro, another outsourcing giant, warned investors that it expects revenue from its software-services business to drop this year.Overall, global tech outsourcing is expected to drop 3 percent this year, according to a recent report by Forrester Research.

"We are living in tough times; the macroeconomic challenges are significant and impacting businesses across segments," Wipro Chairman Azim Premji said in a statement.

Satyam scandal

The scandal involving the Hyderabad-based outsourcing company Satyam centered on $1 billion worth of falsified financial statements. Satyam founder and chairman B. Ramalinga Raju has been arrested and stands accused of inflating the size of its work force by more than 10,000 and diverting wages from fake workers. Its Silicon Valley clients include Adobe Systems, Ariba, Brocade Communications Systems, Oracle, Network Appliance and Symantec.

The fall of the outsourcing giant, once considered a leader in corporate governance, shocked India's IT services industry.

"Satyam has scared the pants off of a lot of people," said Forrester Research analyst Stephanie Moore. "If you can't trust them, who do you trust?"

It has forced executives to look more closely at potential overseas partners.

"I get people stopping me in the hallways asking me, 'Should we be in India? Do we have a diversification plan?' " said Cory Eaves, chief technology officer with British software group Misys, which has 1,000 employees in India and also contracts with outsourcing companies, including Palo Alto-based Symphony Services. "Two months ago, I was not asked those questions."

Outsourcing executives say, only half jokingly, that they fear outsourcing firms will announce they will run out of cash in a month — and demand upfront payments, said Vamsee Tirukkala, co-founder of Zinnov, a Silicon Valley outsourcing consultant.

The Mumbai terror attacks in November added to the uncertainty felt by some company decision-makers, he said.

Still, such concerns are not reversing plans to outsource, particularly for startups trying to stretch their dollars. Pressures to reduce overhead in this bleak recession is intense.

It's particularly critical for small and mid-size companies to find cost relief, Tirukkala said. "They have to reduce their (cash) burn rates."

Companies have frozen new projects, said Gordon Brooks, chief executive of Symphony Services, a product development outsourcing company with extensive operations in India. But not those that need to update product offerings.

"They are afraid of losing their customer base if they don't get the new features out to market," he said. "It's a tricky time. It's not so much about growth. It's about doing well in a down economy and coming through on the other side."

The process of finding an outsourcing partner, though, has become more cumbersome. "There are a lot more questions people are asking, a lot more documentation they are reviewing, a lot more interviews, a lot more reference calls," Tirukkala said.

Overseas presence

He is also seeing a greater interest among companies to set up their own operations overseas, or at least have their own people located near outsourcing partners so they can react quickly to crises. "The biggest thing companies are saying is, 'I have to have some control over my operations,' " Tirukkala added.

It is unclear if U.S.-based outsourcing companies will pick up more business as a result of worries about the stability of foreign-based outsource firms.

"To a certain extent it helps us, being a U.S. company," Symphony Services CEO Brooks said. "But I think people understand Satyam was an anomaly, like Enron."

India, though increasingly faced with competition from lower-cost East Europe and other countries in Asia, remains a relatively inexpensive place to find great engineers, CTO Eaves said.

"They've got this huge skill base and a culture a bit like Silicon Valley," he said.

Contact John Boudreau at jboudreau@mercurynews.com or (408) 278-3496.

Worldwide sales of information technology products and services are expected to drop 3 percent to $1.66 trillion.Global IT services and outsourcing also is expected to drop 3 percent.The United States is expected to account for 34 percent of the global tech market in 2009 and 2010, down from 37 percent in 2005.